The fee and payment system in medicine is a big black box. Patients don’t know the true costs of medical care and we have no clue what bill the patient gets when we order all those tests. There’s a black box with financial advisors also: fees. I have not yet met a physician who knows exactly what fees he’s paying to his financial advisor.
So let’s open the financial advisor black box and look at the actual fees you’re paying. Let’s assume you have $500,000 to invest.
Commission-Based Advisors
A typical class A share mutual fund’s commission is about 5%. The advisor spreads your money across several funds, so on $500,000 you’ve just paid a $25,000 commission up front. That means you’ve only invested $475,000 of your money. Every time you invest new money, you get hit with another commission. Then, if the advisor switches you out of your current funds into new commission based funds, you get hit with the commission on the entire portfolio, not just the new money. For example, after several years of contributions your portfolio is now $750,000. If the advisor switches you to new funds you’ll pay the commission on the entire $750,000 – as high as nearly $40,000! You don’t see this because you don’t get an invoice like you do with your electric bill. Some physicians naively assume that they aren’t “paying anything” to these advisors. Wrong!
The upfront commission doesn’t include the annual mutual fund expenses. Most commission-based advisors use high expense mutual funds – 1.5% annual fund expenses are common. This fee isn’t a direct fee; rather, high mutual fund expenses result in lower portfolio returns. So in the first year you’ll pay $7,500 in mutual fund fees. That’s on top of the 5% commission for a whopping $32,500 in the first year. Subsequently you’ll continue to pay the mutual fund expenses and included in that is the trailing commission, or 12b-1 fee, of 0.25% to 1% annually. That’s between $1,250 and $5,000 annually in trailing commissions on your $500,000 portfolio.
Fee-Only Advisors
Fee-only investment advisors, who are supposed to act as fiduciaries to you, typically charge an assets under management fee based on the value of your portfolio. Here is a typical fee structure:
1% on assets up to $1 million
0.8% on assets between $1 million and $3 million
0.7% on assets between $3 million and $5 million
0.5% on assets above $5 million
You might mistakenly think that the fee goes down as your portfolio goes up. That is not true. While the blended percentage goes down, the actual dollar amount you pay goes up. For example on a $500,000 portfolio you will pay $5,000. At $1 million the fee is $10,000. At $2 million the total advisor fee is $18,000 ($10,000 on the first $1 million and then $8,000 on the next million).
Even with fee only advisors you have to add the mutual fund expenses on top of this. Most fee only advisors also use high cost funds but because there is no 12b-1 fee, the fund expenses are lower than with commission based advisors. Mutual fund expenses of 1% are typical.
So the total fees for a $500,000 portfolio are $10,000 ($5,000 advisor fee + $5,000 mutual fund expenses) or 2% of your portfolio. At $1 million, it’s $20,000. At $2 million it’s $38,000. As you can see this gets really expensive.
Many advisors try to make you think that there’s some sort of mystery to managing a $2 million portfolio versus a $500,000 portfolio so they can justify their high fees. There is some more complexity but not anywhere near what these advisors claim. And if a fee only advisor is supposed to act as a fiduciary, doesn’t part of that duty to you involve charging reasonable fees? Fee only advisors are supposed to act in your best interests but many bury their heads in the sand when talking about their own fees. From your perspective, high fees eat into your portfolio returns and ultimately your retirement.
Of course you can’t just look at the fee. You also have to look at the value that you get for the fee you’re paying. If you have a competent and ethical advisor, the value comes from the objective advice and discipline you get by having the advisor. From the advisor’s perspective the fee has to go up because some of the advisor’s expenses are tied in to the amount of assets he manages. As the advisor manages more assets certain fees like custodial fees and insurance costs go up so the advisor has to charge more for higher portfolio values.
So what is a reasonable fee? I believe that the advisor fee plus the mutual fund expense should total less than one percent.
Just take a look at the following graph to see what your ending portfolio is for two different advisors. The typical fee only advisor charges the fee schedule listed above and the average mutual expense is 1% annually. The second advisor charges 0.5% and uses low cost mutual funds with annual expenses of just 0.2%. Assume you start with a $500,000 portfolio. Before fees each advisor’s portfolio returns 8% annually. The lower cost portfolio results in over $1.2 million in higher portfolio value after 30 years.
Let’s put this into a more practical perspective for EPs. Suppose you make $1500 per shift and $50 for an emergent intubation. You would have to work over 800 more shifts and do more than 24,000 more intubations with the higher cost advisor. Now do you think advisor fees matter?
Setu Mazumdar, MD practices EM and he is the president of Lotus Wealth Solutions in Atlanta, GA www.lotuswealthsolutions.com
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